Wed, 2 Nov 2016
Morningstar's Russ Kinnel discusses the risk/reward tradeoffs of some newer funds under coverage, with ratings spanning from Silver to Negative.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Morningstar's manager research analysts are constantly bringing new funds under coverage. Joining me to discuss some newly rated funds is Russ Kinnel, he is director of manager research for Morningstar.
Russ, thank you so much for being here.
Russ Kinnel: Happy to be here.
Benz: Russ, let's discuss some newly minted fund ratings. Starting with the good ones, starting with PIMCO GNMA, which upon its new rating, earns a rating of Silver. Let's talk about what the team likes there and first of all, maybe let's just talk about what Ginnie Maes are for investors who aren't steeped in the specifics of bond investing.
Kinnel: Right. So, Ginnie Maes are government-backed mortgage pools, and they are high-quality bonds. They come with some weird characteristics. So, for instance, there's prepayment risk. So, what that means is, falling interest rates mean you get your money back at a time when you don't want to. So, there's some quirks to Ginnie Maes. There's some value in hiring a specialist like PIMCO or other fund companies to manage because they are a little tricky, a little complicated.
Benz: So, Ginnie Maes are backed by the full faith in credit of the U.S. Treasury, but have historically had a little bit of a yield premium relative to straight-on Treasury bonds. Let's talk about what you think PIMCO adds there in the Ginnie Mae space.
Kinnel: Right. So, it's an interesting fund because it's less than $1 billion, yet we know PIMCO invests a lot in mortgages and Ginnie Maes in particular through funds like PIMCO Total Return. So, the operations behind this fund are much greater than you might initially expect. PIMCO is just a very good investor obviously in this space. In this particular fund, Dan Hyman takes a sort of relative value approach, which has worked quite well so far, and we think just PIMCO is a very good investor in this area.
Benz: OK. The role of a Ginnie Mae fund in a broader portfolio, how would an investor use something like this and could it potentially be duplicative with something else in the investor's portfolio?
Kinnel: That's right. So, Ginnie Maes typically make up a meaningful slug of your typical intermediate bond fund. So, before you go out and buy a Ginnie Mae fund, be sure you understand what your exposures are elsewhere. If you have a fairly high-quality intermediate bond fund, you may well already have all that you need. However, let's say, you own Treasuries directly or for whatever reason you don't have an intermediate fund or maybe want to focus more on the higher-quality more predictable part of that segment, then a Ginnie Mae fund might make sense. It's kind of a niche, but at least it's a fairly low-risk niche.
Benz: That's true. Let's talk about another one. This is a Bronze-rated fund. This is American Beacon International Equity. Let's talk about its setup: It uses a multimanager subadvisory setup. What do you like about that general setup for mutual funds?
Kinnel: Yeah. So, I think there's some appeal there in having multiple subadvisors because it takes out some of that idiosyncratic risk that you get when you just have one manager. In this case, you have three value managers and of course, as you know, every value strategy has its moment where it can look pretty poor. Often it's because of recession or maybe a sector that they like, like energy, is hit hard. So, spreading that out over three subadvisors, as they do in this fund, is not such a bad idea. In a way, it means you could, if you wanted to, make a fund like this your sole foreign holding.
Benz: OK. So, the idea with a subadvised fund is, these are not American Beacon managers. They are managers who American Beacon hires to run. And as it turns out, Morningstar really likes some of these underlying managers. We've got Causeway, Templeton...
Kinnel: And Lazard.
Benz: And Lazard. OK.
Kinnel: And so, we rate Causeway Gold. We rate the other two Bronze. And in some cases, this fund is going to be cheaper than buying those funds--the related funds directly. So, I think, it's pretty good value and of course, when you have three portfolio managers with a more diffuse portfolio, costs are really important. So, I like that element here, too.
Benz: OK. Let's talk a little bit about American Beacon. What is this firm? Investors may not be familiar with this name, and how do they buy these funds?
Kinnel: Yeah. American Beacon used to be part of American Airlines, running their pensions. Now they are separate from American Airlines. But as you say, that's what they do. They don't run anything directly themselves. Their job is to hire multiple subadvisors. They like value strategies and oversee them. But they tend to do it with a relatively light hand. That is, they don't make rapid changes. They will make changes, but they tend to be fairly stable, low turnover with their subadvisors. And historically, they've done a pretty good job of finding good ones, as they have in this case.
Benz: OK. USAA Income has a Neutral rating. USAA has historically been a pretty low-cost provider and a decent bond manager. What is the thinking behind this fund's Neutral rating?
Kinnel: That's right. USAA, we like in general because they are lower cost, they are pretty straightforward. In this case, though, the fund has a little more credit risk than your typical intermediate bond fund. They have got a big slug of BBBs, which is the lowest rung of investment-grade, and then they have got about 10% in actual high-yield. And if you look at it, the returns are decent. But given the added risk, it really doesn't add up for us. So, it's an OK fund, Neutral, but again, we don't see anything that compelling yet.
Benz: OK. The last fund I want to discuss is Eaton Vance Multisector Income. It has a Negative rating. Let's talk about what's going on there, because it does have a very experienced manager in Kathleen Gaffney, who came over to Eaton Vance from Loomis Sayles. Let's talk about the issues that the team thinks are in play there.
Kinnel: That's right. You have an experienced manager in Kathleen Gaffney, but it's really been a disappointing fund. She came over from Loomis Sayles and as you probably know, Loomis tends to run these funds that have a pretty wide-ranging investment in a lot of areas, take on some credit risk, have a lot of foreign currency and foreign debt exposure, even have a Canadian bias and that's here in this fund.
Benz: Some straight-up equity exposure.
Kinnel: And some straight-up equity exposure as well. So, on the high-risk end of bond funds, but what's different here from the Loomis Sayles funds is greater concentration, so greater sector concentration, greater issue concentration, and that worries us when we see a really high elevated level, especially in bond funds where people tend to want a little lower risk, and that risk really showed up. So, it's not just that they are taking risk, but they got it wrong; they had big energy bets, and the fund lost over 17% in 2015 compared with about a 2% loss for the typical peer.
So essentially as a fund, if you look at its returns over the about three-and-a-half-year life of the fund, the returns are not so far off from the category average, but with massively higher volatility and risk. And you put all that together, it's just not a very appealing package. There have also been some personnel changes. So, really, kind of on multiple fronts we see concerns.
Benz: Yeah. OK. Hard to see how a very high-risk bond fund fits in most investors' portfolios.
Benz: OK. Russ, thank you so much for being here to discuss these newly rated funds with us.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.